National Institute of Economic and Social Research

Tuesday, 17 April 2012

Who wants to tax and spend? the IMF, that's who.

I noted at the turn of the year that the IMF, since Christine Lagarde took over, had made it more and more obvious that it thought a number of countries, including the US, Germany and (by implication) the UK, were tightening fiscal policy too fast. In January, in its quarterly update of the World Economic Outlook (WEO), the Fund said:

"those [advanced countries] with very low interest rates or other factors that create adequate fiscal space, including some in the euro area, should reconsider the pace of near-term fiscal consolidation. Overdoing fiscal adjustment in the short term to counter cyclical revenue losses will further undercut activity, diminish popular support for adjustment, and undermine market confidence."

Today the Fund has released the full WEO. It makes it still more obvious that the Fund thinks that, in the short-term, the problem is above all a lack of demand, and that excessive austerity is, as Paul Krugman and Brad DeLong have argued, self-defeating: .

"Given still-large output gaps in many advanced economies, the best course for fi scal policy is to adopt measures that do the least short-term harm to demand and preclude unsustainable long-term paths"

As ever, the Fund is reluctant to criticise the policies of large and influential member countries directly (the US is an exception at the moment, since criticising US fiscal policy at the moment is essentially to criticise the antics of the Republican-controlled Congress rather than the policies of the Obama Administration). In particular, the Fund is very careful to avoid specifics when it comes to the UK, for understandable political and diplomatic reasons (and remember the Fund is also looking to secure substantial new resources from its members!). However, this passage is fairly clear:

"Given the weak growth prospects in the major economies, those with room for fiscal policy manoeuvring, in terms of strength of their fi scal accounts and credibility with markets, can reconsider the pace of consolidation."

The Fund's own analysis shows that the UK does have room for manoeuvre, so the implication is obvious, even though they won't say so. However, leaving this debate to one side for the moment, a very interesting new point is that, in a passage even more explicitly targeted at the UK, the Fund calls directly for "balanced-budget fiscal expansion."

"Given concerns about fiscal room, a balanced budget fiscal expansion could support activity and employment while keeping fiscal consolidation plans on track. For example, temporary tax hikes matched by increases in government purchases— for much-needed infrastructure—could lead to an almost equal rise in output. Government spending targeted to distressed households that spend all their disposable income will yield a similar increase in output."

In other words, the Fund wants us, for standard Keynesian reasons, to spend more on infrastructure (and housing) and increase welfare benefits for poor people (who will spend them), and pay with it by taxing the rich (those with a lower "marginal propensity to consume". This would raise demand in the short term, without worsening the fiscal position. For those who see the Fund as being both anti-Keynesian on macroeconomic policy, and classically "liberal" on microeconomic policy, this will come as something as a shock.

In the UK, this is precisely what Simon Wren-Lewis and Ian Mulheirn have been arguing for. Indeed, Simon asked plaintively "Why is no one talking about balanced budget expansion?; well, they are now. The idea is entirely sensible from an economic perspective; the problem is the tax rises and spending cuts needed to make the sums add up. Ian's preferred package, which I imagine the Fund would endorse, includes the following:

I leave it to others to assess the political realism of these measures, sensible as they may be. And I still think the Fund should be clearer that UK fiscal policy is simply too tight. Nevertheless, the Fund's analysis should be commended; it is based on good economics, both theoretical and empirical, rather than blind faith; and it shows they've been reading, and understanding, what serious economists like Simon and Ian have been writing, rather than talking to the credit rating agencies.

In this the Fund's approahc stands in sharp contrast to the economic illiteracy and political supineness of both the OECD and the European Commission. Although the OECD continues to lead the world in the quality of its comparative microeconomic analysis (especially on labour market policy and immigration), its macroeconomic policy judgement has proved absolutely abysmal - remember that as recently as last May they were advising us all to raise interest rates. As for the European Commission, my thoughts on the people who brought us Spain and Greece - and youth unemployment over 50% - are here and here.